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International Monetary Fund

, but that was in part a reflection of an unusually large and sudden revision of expectations. What is more, in contrast to the two big bouts of turbulence in ERM foreign exchange markets, this time the authorities did not act forcefully to supply liquidity to the markets. As such, more of the adjustment to a new equilibrium was taken up by price changes. Role of Hedge Funds Because hedge funds have been active participants in the ERM crises of 1992–93, as well as in the recent bout of turbulence in bond markets, and because their potential market influence

Mrs. Anne C Jansen, Mr. Donald J Mathieson, Mr. Barry J. Eichengreen, Ms. Laura E. Kodres, Mr. Bankim Chadha, and Mr. Sunil Sharma

Abstract

Hedge funds are collective investment vehicles, often organized as private partnerships and resident offshore for tax and regulatory purposes. Their legal status places few restrictions on their portfolios and transactions, leaving their managers free to use short sales, derivative securities, and leverage to raise returns and cushion risk. This paper considers the role of hedge funds in financial market dynamics, with particular reference to the Asian crisis.

Mr. Barry J. Eichengreen and Mr. Donald J Mathieson

H edge funds are collective investment vehicles, often organized as private partnerships and resident offshore for tax and regulatory purposes. Their legal status places few restrictions on their portfolios and transactions, leaving their managers free to use short sales, derivative securities, and leverage to raise returns and cushion risk. This occasional paper considers the role of hedge funds in financial market dynamics, with particular reference to the Asian crisis. While hedge funds are large in absolute terms, they are dwarfed by other institutional

International Monetary Fund

liabilities. Later in the fiscal year, in March 1998, the Board examined the role of hedge funds and institutional investors both in connection with the Asian crisis and, more generally, in a world of increasingly integrated capital markets. 6 Mature Capital Markets Directors noted the narrowing of interest rate differentials among the mature economies and attributed this to several causes, including fiscal consolidation, reductions in inflation rates, and increased competition in international banking markets. Directors also saw the continued convergence of interest

International Monetary Fund. External Relations Dept.

Since the 1998 crisis surrounding the U.S.-based Long Term Capital Management (LTCM) fund, the hedge fund industry has grown considerably (see chart). Although the industry remains relatively small compared with other asset classes (for example, U.S. mutual funds), its rapid growth has renewed calls for more oversight and possible regulation and raised questions about the role of hedge funds in certain markets, including the energy markets. In Chapter II of the September 2004 Global Financial Stability Report, the IMF argues that a better understanding of the hedge fund industry is essential before taking policy actions, including the possible regulation of what is largely an unregulated sector. The report also takes issue with pinning recent energy price hikes solely or primarily on hedge funds. Conny Lotze of the External Relations Department explores these issues with Todd Groome, Division Chief, and William Lee, Senior Economist, in the International Capital Markets Department.

International Monetary Fund

Abstract

This paper analyzes the origins of the recent turbulence in government bond markets in the major industrial countries, and considers whether the role of hedge funds in that episode argues for altering present regulatory arrangements. In financial markets, it is possible for such a revision of expectations—if it is shared by all market participants—to alter asset prices almost immediately; indeed, the change in asset prices can occur without any transactions even taking place. In this case, however, trading volumes soared along with the rise in bond yields, as a broad spectrum of market participants sought to undo large positions that had been built up under the projections of a continued rise of European and US bond prices and a strengthening of the dollar against the yen and some European currencies. Although the increase in bond yields was undeniably large for such a short time period, the markets did receive new information in February and March on economic performance—especially on growth rates—and on the likely future course of macroeconomic policies.

International Monetary Fund

analyzes the origins of the recent turbulence in government bond markets in the major industrial countries, and considers whether the role of hedge funds in that episode argues for altering present regulatory arrangements. Section III addresses recent initiatives to reduce systemic risk in the rapidly growing market for derivatives, as well as two ongoing debates about the most appropriate way to design and to implement supervision over banks and nonbanks. Section IV reviews recent trends in external financing for developing countries, with particular reference to the

International Monetary Fund. External Relations Dept.

States, continued structural reforms to boost growth in Europe and Japan, and, in emerging Asia, steps toward greater exchange rate flexibility, supported by continued financial sector reform, as appropriate. Also, improving information and transparency in markets, including the role of hedge funds, would help strengthen market surveillance. The Committee welcomes the recent improvement in Argentina’s fiscal position since 2002. The Committee supports that Argentina decisively addresses all the outstanding structural issues in its program, completes a comprehensive and